The Best Bank Gets Better

Published in Company Comment on 8 May 2012

A 4.7% yield, enviable emerging markets growth and a low P/E.

The banking sector has come in for some criticism since the credit crunch struck, but in my view not all UK banks are equally deserving of the bashing they have received.

The biggest bank in the FTSE 100, HSBC Holdings (LSE: HSBA), avoided the stigma of being bailed out and has recovered relatively fast from the crisis. It's currently in the middle of a worldwide revamp of its operations that is intended to cut costs and increase its focus on Asia.

Today's Q1 interim results give us a good opportunity to review HSBC's progress so far.

Profits up?

HSBC has its roots in Asia and it has always retained its emerging market focus. In 2011, 78% of its profits came from Asia Pacific, Latin America, the Middle East and North Africa, with the remainder coming from Europe. This trend continued in the first quarter, with profits before tax rising by 21% in Hong Kong, 24% in the rest of the Asia-Pacific region and 11% in Latin America.

Overall, underlying profit before tax rose by 25% from the first quarter of 2011 to $6.8bn. However, total reported profit before tax for the quarter fell by $0.6bn to $4.3bn, thanks to the rising value of HSBC's own debt over the last year. This is a contentious and counter-intuitive accounting practice that caused Royal Bank of Scotland (LSE: RBS) to report a loss rather than a profit in its recent quarterly results and recently led Barclays (LSE: BARC) to fall foul of the taxman.

HSBC's core tier 1 capital ratio also improved, rising from 10.1% to 10.4% over the quarter.

A wider moat

One example of HSBC's careful positioning for future growth comes from India, where the bank is currently completing the acquisition of the majority of RBS' Indian operations. The deal was announced two years ago, but has taken until now to get regulatory approval.

By far the most attractive aspect of the deal is the 20+ extra branches it will give HSBC in India. It is hard for foreign banks to get approval to open branches in India, but HSBC already has 50 and the RBS branches will make it the second-largest foreign bank in India, just behind Standard Chartered (LSE: STAN).

The value of this deal is twofold: it will give HSBC improved access to India's burgeoning middle classes and SME business market -- an essential avenue to retail banking growth -- and it raises the barrier to entry for any foreign competitors.

HSBC has also recently agreed to acquire Lloyds Banking Group's (LSE: LLOY) operations in the United Arab Emirates. HSBC's profits in the Middle East rose by 67% in 2011 and the area is a key growth market, especially for retail banking and wealth management clients.

Buy now, hold forever

While I can't guarantee that HSBC will be a 100-year share, it is certainly a company that is positioning itself skilfully for long-term growth.

HSBC's current market value of £100bn means that it is trading a fraction below its net asset value of £107bn, on a price-to-earnings ratio of about 9.5. In addition, offers an attractive dividend yield of nearly 5%. Added together, it all seems cheap, and I for one am happy to own shares in this bank.

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> Roland owns shares in HSBC but does not own any other share mentioned in this article.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

Afrosia 08 May 2012 , 12:22pm

It's still a bit complicated though, and likely to be subject to a lot of regulation.

Given the paltry returns on equity on offer, I would feel more comfortable holding Tesco with its similar yield because it's easier for idiots like me to grasp and I suspect that it had the potential to grow its dividend at a greater rate and with less risk.

IMHO, a bank can be a great bank but an average business..

dpeddlar 08 May 2012 , 4:13pm

I think that if the growth story was not without hurdles we would have to pay a much higher price for the shares. Also I expect alot of people think along the same lines as Afrisia (as the comments above make alot of sense) however sometimes the best returns come when you don't follow the herd.

Anyway I am happy to hold and add because of the divi, potential for growth and because I think the best time to buy into a company is when sentiment is negative for the stock or sector which must apply to banks right now.

equitybore 08 May 2012 , 5:53pm

My three questions: Does it know what it is doing? Broadly yes after the disaster of the US. Does it have competitive advantage where it focuses? Yes. Does it have a nice divi? Yes.

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